Derivatives Trading Basics
by 5paisa Research Team Last Updated: 2022-06-15T18:29:13+05:30

What Is An Option?

Firstly, an option is a financial derivative that gives the buyers the right to buy or sell an underlying asset at said date and agreed price. This means that there is no compulsion must buy or sell the underlying asset. However, it is not an obligation.

Next, let us try to understand what is a call option. Let us consider the underlying asset here as a stock. The call options give the holder the right to buy a stock at a particular price until a specific date. The price that has been set is known as the strike price. The specified date is known as the expiration date. 

Now that we have an understanding of what is an option and what is a call option. Let us dive right into what is Index call.

One of the main reasons people prefer index call is that the risk is minimal. Also, there is very little capital put at risk here. While the profit that might be made out of this is unlimited, the loss or the risk is limited to the premium paid for the option. 

There is a reason why the index call is a preferred option among the buyers. This is mainly because of the flexibility it offers the buyers. There is a fee to purchase the option, and it is called a premium. When the asset is below the agreed price, the buyer will have to forfeit the premium that was paid. 

Also, if the price of the underlying asset is above the strike price at the time of expiry, the buyer's profit is the difference in prices minus the premium paid while buying this option. The total is then multiplied by how many shares the buyer controls.

What Are The Types of Call Options?

There are two other types of call options: Long call and Short call option. A long call option is a standard call option where the buyer has the right to buy or sell, but there is no obligation involved. However, in the case of the short option, it is quite the opposite. Here, the seller has a promise to sell their shares at a fixed price. This type of option is usually used by people who already own the underlying stock for their option. 

Of course, if things do not go in their favour, it might result in a loss of premium for the investor. Using the short option like this can help contain the losses (which might happen if the market situation does not swing according to their favour). This type of option is also used to generate income. Sometimes these options are also used in case of speculations. There are times when these options are used for tax management.

Conclusion

The bottom line is that they are speculative instruments that only make money when the price of the underlying asset increases. Did you find that blog useful? If you have any further questions, don't forget to mention them in the comments section!

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